So when people talk about finance, investment, retirement, etc. they always just throw 3 numbers at you (529 – College Savings Plan is one of them).
“I maxed my 401k, but need to rebalance my 403b. Then I need to contribute some more to my 457b. I also need to set up that 529 for my kids.”
*What is a 529?
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as qualified tuition plans (QTP) are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code. Source
*Ok… so what does that mean?
To put it simply, it’s another place to take your post-tax money and allow it to grow tax free. However, the caveat is that when you withdraw the money it must be used for pay for “student’s qualified education expenses at a postsecondary institution.” However, this does not include only tuition… it also includes:
Books, supplies, and equipment
Room and board costs
Computer, peripheral equipment, software and even Internet access (note that software must be primarily educational in nature, so, like Microsoft Office)
Source (page 59 again)
*Wow… that sounds pretty great.
It really is.The problem is that if you are a family living month to month, putting money into a 529 is simply not a priority.
This is why I advise you to keep a 529 as an important part of your budget as soon as possible.
*What if Junior doesn’t use all the money in his 529?
Well, he can either save it to use for higher education later (graduate school, etc). or he can roll it over and give it to one of his siblings, his spouse, or his kids. Source (page 62).
*Ok, wow, 529 sounds pretty great. But would it really help all that much? College is going to be so expensive by the time my kids will need it.
You’re right… but only half right. Remember, compound interest still works for you here. Nobody knows how much college will cost in the future. For me, my daughter will start college in 2032. Just to round things down, let’s assume 2030. There are a few articles that have been written which have approximated the costs of college.
US News and World Report predicts it will be $44,047 a year for a public institution.
CNBC predicts it will be $41,228 a year for a public institution.
Business Insider predicts $40,935 a year for a public institution.
Their estimates are similar to one another, so probably 40-45k is a good bet. Over the course of 4 years, $200,000 seems like a good estimate. Let that sink in. $200,000. TWO HUNDRED THOUSAND DOLLARS — Just for college TUITION. This does not include room/board, living expenses, and all that pizza and beer. I think you can just go ahead and double that number if you decide to go private, meaning $400k for tuition over 4 years.
*You’re not doing a great job convincing me here, Sensei…
Yea. I know. But here’s the thing. A 529 is not supposed to be used to pay for everything. It is just to help your children (and you) not be saddled with huge loan payments before they even get their first job or go to medical school. Can you imagine the amount of loan burden my daughter would have if she decided to go to medical school? $200,000 for tuition for public undergrad, another 200k for public med school. That is $400k before she even starts residency, and that is $800k if she goes to private school… and I’m not including room and board OR interest yet!
Is it any wonder why it’s hard to say whether I would do it again?
*Ok then… how much should I try to pay for?
Well, that is something you as a parent must decide. Some parents might think “I have to pay for college, like my parents did for me.” and then this is a matter of great importance. Others, might not be quite as aggressive and just want to pay for “some”. Others may think to themselves “I’ll do what I can.” Everyone’s situation is different. However, I will weigh in on what I plan to do:
It is impossible for me to save enough money to pay for 100% of private college. Also, I don’t plan to save enough to pay for graduate school. My parents paid for my college, and for that I am forever grateful. (Thanks Mom and Dad, by the way. I never understood how hard it must have been, until I became a father.) However, I went to medical school on my own and took out the loans in my own name.
For me, having loans to my name made me take responsibility for my future and I pushed myself to do my best. So then, from the data above, 4 years of public college will cost $200k, for tuition alone. I will try my very best to save about that much money over the next 15 years for my daughter, and then next 17 years for my son for each of them, in their 529s. Will I be able to do it? Who knows. It depends on the market and the returns, but I will try my best.
*$200k…? For each of them? Are you crazy?
Well yes. My wife, the psychiatrist (an excellent one by the way) reminds me daily that I am crazy for working like I do and still taking time to write this blog of mine.
However, let’s just plug some numbers into the compound interest calculator:
For my daughter (3 years old):
$1 principal, $500 a month, 15 years to grow, 7% interest is…. $150,776.89 — not bad right?
Yes, that’s $500 a month and yes, that’s very hard to do. And no, I’m not doing it yet… but I plan to once a bunch of costs from buying a house have calmed down. Additionally, once she is in public school and I save money from her not being in daycare, I can probably increase it a little.
Ok let’s be a little more realistic… and say I simply can’t put any money aside until she is out of daycare (which is probably true). Her daycare is $1500 a month, yes, fifteen hundred dollars a month. She starts public school in 2 years at the age of 5. So let’s say instead, I take the money I would have paid to daycare and put all of it into her 529 every month instead:
$1 principal, $1500 a month, 13 years to grow, 7% interest is…. $362,533.98 — wayyyy too much (in my opinion).
For my son (~1 year old):
$1 principal, $500 a month, 17 years to grow, 7% interest is…. $185,044.46 — looking pretty good. Those extra 2 years helped.
*So what’s the REAL scenario for both of them then?
The (probably) real scenario is that once they are out of daycare and in public school, I will probably put $700 or $800 a month for each of them once they are out of daycare:
$1 principal, $700 a month, 13 years to grow, 7% interest is…. $169,183.81 — seems reasonable
$1 principal, $750 a month, 13 years to grow, 7% interest is…. $181,268.20 — sounds good
*Sensei, you’re crazy, I can’t put away that much… like EVER.
I can’t either… yet. But I plan to as I delineated above.
Let’s be simple instead. Junior is born, you make a 529, you put $100 in it a month for him, direct deposit from your bank every month and never touch it again.
$1 principal, $100 a month, 18 years to grow, 7% interest is…. $40,802.22 — that’s enough to cover one year tuition and you probably won’t feel it (as an attending).
*$100 a month? I can do that, I think.
Ok, how about $200 then?
$1 principal, $200 a month, 18 years to grow, 7% interest is…. $81,601.06 — 2 years tuition
Just remember: the earlier you start, the more you get. (This is a case of do as I say, not as I do, since I only recently opened 529s for my kids.)
*Ok, so I need a 529, I’m convinced. Which one do I use?
I’m glad I’ve convinced you. I’ll talk about how to choose a 529 in my next post, next Friday.
Also, please understand these examples are very, very simplified in terms of interest rate. The time period for which you have a 529 is usually between 10-18 years and the volatility of returns increases with the shorter amount of time. For this reason, the lazy portfolio and the “age in bond” mantra does not work for 529s. You can also claim losses from your 529 if it’s a down year for you. I will discuss all of this in further detail in my next post as well.
Public college tuition is estimated to cost $200k over 4 years in 2030.
529s are tax-advantaged accounts for the purposes of higher education, but are not JUST for tuition.
How much you put into it is up to you.
Just remember, compound interest works for 529s also.
The earlier you start, the more you get.
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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